Moross Ltd. v. Fleckenstein Capital

• Decision Date: 24 October 2006
• Docket Number: No. 05-2280/2312.,05-2280/2312.
• Citation: 466 F.3d 508
• Parties: MOROSS LIMITED PARTNERSHIP, Plaintiff-Appellant/Cross-Appellee, v. FLECKENSTEIN CAPITAL, INC., William Fleckenstein, and RTM Fund, L.P., Defendants-Appellees/Cross-Appellants.
• Court: U.S. Court of Appeals — Sixth Circuit

466 F.3d 508

MOROSS LIMITED PARTNERSHIP, Plaintiff-Appellant/Cross-Appellee, v. FLECKENSTEIN CAPITAL, INC., William Fleckenstein, and RTM Fund, L.P., Defendants-Appellees/Cross-Appellants.

No. 05-2280/2312.

United States Court of Appeals, Sixth Circuit.

Argued: September 20, 2006.

Decided and Filed: October 24, 2006.

ARGUED: Bradford T. Yaker, Bradford T. Yaker, P.C., Bingham Farms, Michigan, for Appellant. M. William Munno, Seward & Kissel LLP, New York, New York, for Appellees. ON BRIEF: Bradford T. Yaker, Bradford T. Yaker, P.C., Bingham Farms, Michigan, for Appellant.

M. William Munno, Seward & Kissel LLP, New York, New York, John H. Dudley, Jr., Butzel Long, Detroit, Michigan, for Appellees.

Before: CLAY and GILMAN, Circuit Judges; STAFFORD, District Judge.^*

OPINION

GILMAN, Circuit Judge.

This case arises from the investment of $750,000 by Moross Limited Partnership into the RTM Fund, L.P, a private investment fund. After the RTM Fund lost 90% of its assets due to an unsuccessful strategy of "short-selling" in the securities market, Moross sued the RTM Fund, its general partner, and its investment manager (collectively, the defendants). Moross's suit alleged violations of Michigan's Uniform Securities Act (MUSA), fraud, and breach of fiduciary duty. Both sides moved for summary judgment after a lengthy period of discovery. In addition, the defendants moved for sanctions under Rule 11 of the Federal Rules of Civil Procedure and 28 U.S.C. § 1927. The district court granted summary judgment in favor of the defendants, but denied their motion for sanctions.

On appeal, both parties renew their arguments made below. The defendants further move for sanctions under Rule 38 of the Federal Rules of Appellate Procedure because they claim that Moross has pursued a frivolous appeal. For the reasons set forth below, we AFFIRM the judgment of the district court, but DENY the defendants' motion for sanctions on appeal.

I. BACKGROUND

A. Factual background

In December of 1996, William Fleckenstein, the sole shareholder of Fleckenstein Capital, Inc., sent a letter to Stanley Dickson, a Michigan attorney, accountant, and investor, soliciting him to invest in the RTM Fund. The RTM Fund, a Delaware limited partnership that invests in publicly traded securities, was managed by Fleckenstein Capital as its General Partner. Fleckenstein Capital is based in the state of Washington. Included with the solicitation letter was a "Confidential Private Offering Memorandum" (Offering Memo), which explained that, because "[t]his is a private offering[,] ... [t]he limited partnership interests offered hereby have not been registered with or approved by the Securities and Exchange Commission or any state securities agency."

In April of 1997, Dickson established the Moross Limited Partnership as the vehicle for his investment in the RTM Fund. As Moross's sole general partner, Dickson invested $750,000 with Moross, which was later transferred into the RTM Fund.

The primary investment strategy of the RTM Fund was to "sell short," which meant that the fund would borrow and then immediately sell shares of a stock that it did not own with the intent to buy the shares back at a later time in order to close out the transaction. If the price of the stock dropped between the sale and the later purchase, then the RTM Fund would profit by selling high and buying back low. Only "accredited investors"— defined by Rule 501 of the Securities and Exchange Commission (SEC) as an individual with a net worth of at least $1,000,000 or an entity with assets of at least $5,000,000—could invest in the RTM Fund because of its private status and its exemptions from the SEC's public-offering regulations. In addition to Dickson and other investors, William Fleckenstein, along with his mother and his sister, personally invested over $1.1 million in the RTM Fund. Fleckenstein also personally invested in a separately managed account (the Fleckenstein Account) as he was permitted to do under the Offering Memo.

The RTM Fund's short-selling strategy proved very unprofitable during the bull market of 1998-2000. In April of 2000, Dickson requested spreadsheets detailing the daily totals of profits and losses from both the RTM Fund and the Fleckenstein Account. Dickson concluded that these spreadsheets demonstrated improprieties on the part of Fleckenstein; namely, that Fleckenstein had been allocating profitable trades made from the RTM Fund's assets into the Fleckenstein Account, but assigning losing trades to other investors, including Moross. Dickson confronted Fleckenstein with his suspicions about this so-called "cherry-picking" of trades. Thereafter, Fleckenstein transferred $221,500 from his own personal account to the RTM Fund. Fleckenstein did this, according to his declaration, to equalize the short-selling losses for both accounts during that calendar quarter "so no one could say the Fleckenstein Account had done better trading securities than the RTM Fund" during that time.

Dickson received his pro rata share of this transfer, which was approximately $2,000. Dissatisfied with Fleckenstein's response as compared to the total losses that Dickson had incurred, Dickson withdrew Moross from the RTM Fund. Moross then received approximately $75,000, which was all that remained from its original investment of $750,000.

B. The complaint

In November of 2001, Moross brought suit against the defendants. Based on the spreadsheets furnished by Fleckenstein, Moross alleged that when trades earned profits, Fleckenstein assigned these profits to the Fleckenstein Account, while losses were assigned to the RTM Fund investors. The complaint further alleged that when "Dickson telephoned Fleckenstein to inquire about these `suspicious' trades[,] Fleckenstein admitted his wrongdoing and advised Dickson's agent that he would refund to Dickson his initial investment." According to the complaint, Fleckenstein reneged on this promise, but later disgorged $221,500 and applied it to the RTM Fund.

Moross's complaint enumerated four grounds for relief. First, Moross alleged that Fleckenstein violated the MUSA by "misrepresenting how profits and losses in the Fund were to be allocated and failing to disclose his plan to keep profitable trades in his own account." Moross claimed that it invested in the RTM Fund in reliance on the fact that Fleckenstein would "act consistent with his fiduciary duties as managing member of Fleckenstein Capital and General Partner of the Fund." Next, Moross's complaint sought an accounting of all trades made by Fleckenstein with money from his own account and for the accounts of his affiliated entities, in addition to an accounting "as to how all Fund profits and losses were allocated during the period of time that [Moross] was an investor in the Fund." Moross's two remaining claims of fraud and breach of fiduciary duty were similarly based on the alleged false representations made in the Offering Memo regarding how defendants would allocate the profits made with the RTM Fund's assets.

C. Testimony and proceedings below

In April of 2002, the defendants moved to dismiss the complaint pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure for failure to plead fraud with particularity and for failure to state a claim, respectively. Moross, in opposition to the motion to dismiss, reiterated its claim of "cherry-picking" and argued that "over the brief period Dickson had access to the broker's spreadsheets, Fleckenstein's personal account flourished, while RTM lost most of its value." The district court found that Moross's factual allegations were sufficient to survive a Rule 12(b)(6) motion and that Moross had pled fraud with sufficient particularity.

Deadlines for completing discovery and amending the complaint were initially set for November of 2002, but the district court extended this deadline until March of 2003. Moross attempted to demonstrate its cherry-picking claim using a "representative sample" of Fleckenstein's trading records. The defendants produced more than 9,000 pages of documents, including the RTM Fund's daily records and financial audits conducted by the accounting firm of Ernst & Young.

Moross was asked in several interrogatories to identify the trades that it believed were improperly assigned as part of Fleckenstein's alleged cherry-picking scheme, but it never provided answers to these interrogatories. In April of 2003, the defendants moved for summary judgment on the grounds that Moross "has not identified in its answers to interrogatories any securities trades that Mr. Fleckenstein allegedly cherry picked" and that there was no evidence in the record of a cherry-picking scheme. Moross's response, filed in May of 2003, included an affidavit by William A. Collison that purported to demonstrate that factual disputes existed as to the cherry-picking claim.

Collison, whom Moross describes as a "security industries expert," spent approximately eight and a half hours reviewing the files in this case. He averred, in relevant part, that

[a]lthough the RTM Fund Confidential Private Offering Memoranda [sic] permitted Fleckenstein to maintain and invest funds in his own name, it articulated a very specific investment strategy. Despite a purported consistent, unified investment strategy and discipline, Fleckenstein's personal account inexplicably out performed the RTM Fund. For example, on February 29, 2002, the RTM Fund lost 8.03% that day, while Fleckenstein's personal account gained 1.23%. That same day, the RTM Fund was down 22.72% for the year, while Fleckenstein's personal account was up 38.44%. The disparity in performance between the RTM Fund and Fleckenstein's personal account exceeded an astonishing 71%. This fact alone constitutes circumstantial evidence that Defendants committed acts of "front running" and "cherry picking."

Moross's response also included a new factual basis for its claims of fraud...